By Johann Plé, Green Social and Sustainability Bonds Strategy Manager at AXA IM
2023 might be the year of the bond market revival. Uncertainties remain high but there are growing signs that headline inflation is abating, that growth is coping better than expected and that central banks’ tightening cycle might soon come to an end. This context should be particularly favourable to the Green, Social and Sustainability (GSS) bond market.
As regulation steps in and strengthens scrutiny over sustainable investment, GSS bonds should further benefit from the transparency they provide. Looking at green bonds, our research has demonstrated that the carbon intensity of the projects financed are more than twice as low as the one of their issuers. Thus, they are fulfilling their primary role of financing projects with a positive impact on the environment while also offering investors a market that is liquid and growing in its potential to achieve large tradeable volumes.
We have identified three reasons for optimism for the green, social and sustainability bond market in 2023:
1. A very dynamic market…
Amid turbulent economic conditions in 2022, green, social and sustainability bonds still registered $606 billion of new issuances, mainly driven by the green bond market, accounting for close to $400 billion of issuances. 2022 managed to keep apace with 2021’s record in terms of volume of issuance on the green bond market, and the year welcomed an additional 115 new issuers. Credit accounted for more than 50% of total issuances for the third consecutive year, thanks to an increasing sector diversification coming from the real estate, automotive, consumer goods, or telecommunication sectors. Meanwhile, sovereign issuance continued to pick-up, with new countries such as Austria or Canada issuing their first green bonds. This reflects not only the credibility of green bonds when it comes to support the financing needs of the Net Zero transition but also that every sectors are progressively investing in such transition. Looking ahead, there are reasons to believe that this sector diversification should also be accompanied with greater regional diversification. One could expect higher issuance for US corporates, especially on the back of the US Inflation Reduction Act, while Emerging issuances should continue to pick-up as a successful global transition cannot be achieved without significant investment in the area.
The Social and Sustainability bond market dynamic was a bit more nuanced. Yet, it is worth highlighting that we saw the first social bond issuance from a Real Estate issuer, potentially paving the way for more corporate issuances in the segment. Meanwhile, digging into the sustainability bond dynamic, it is worth noting the strong contribution of USD issuances compared to Green and Social bonds which remain dominated by EUR issuances. These dynamics continue to bring a wide range of diversified investment opportunities from both a sector and geographical perspective.
2. …with attractive valuations.
The rebound in yield levels at the end of 2022 has helped valuations to look increasingly attractive. In the short term, the picture remains uncertain: central banks pursue their tightening cycle to bring both headline and core inflation down and the supply pipeline looks incredibly heavy over the first quarter. Yet, the long-term picture looks more and more compelling for the bond market and should be particularly beneficial to GSS universe given its credit exposure and sensitivity to interest rates. Indeed, we believe that some of the factors that explained the underperformance of the GSS universe compared to the conventional universe in 2022 will reverse in 2023. The GSS universe currently enjoys an attractive yield pick-up compared to the conventional universe and looks better positioned to benefit from a decline in yields and compression of credit spreads.
3. Tougher regulatory pressures and increasing climate and social awareness should continue to drive interest in this asset class.
Sustainable strategies have benefited from growing investor appetite over the past years. As regulation steps in, it is crucial to be able to continue to demonstrate the credibility of these strategies. GSS bonds offer a very appropriate instrument that combine transparency and measurability of the projects funded. We believe this should be particularly beneficial to the asset class and attract both new investors and new issuers.
The transition to net zero requires massive investments over the coming years. For example, a recent study showed it would require an extra $3.5 trillion a year in capital spending on physical assets for energy and land use systems to succeed by 2050. Initiatives such as RePowerEU or the Inflation Reduction Act in the US are likely to support these investments and should be beneficial to GSS bonds.
On the social side, the strikes and cost-of-living related challenges are exasperating the inequalities across populations. Alongside this, low income households in developed and developing countries are on the front line when it comes to bearing the cost of both climate change disasters and a transition to net zero. With this in mind, we could see a resurgence in social bonds in 2023 with a growing focus on the S pillar.
If the perspectives are positive for the market, investors should nevertheless remain cautious when investing in sustainable bonds. The crux is the ability of asset managers to invest in meaningful projects from credible issuers though a strong analysis. The capabilities of the asset manager is key here and this is why at AXA IM we have developed a powerful GSSB framework that allows us to be very selective on this market.
Last but not least, we will closely follow and contribute to the evolution of the regulation pertaining to the upcoming green then social taxonomies, how they will work with SFDR and the current local ones – no doubt we will all need to adapt, but these should not impede our increased ambition to contribute to a green and just transition.
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